HMM Based Scenario Generation for an Investment Optimization Problem

>HMM Based Scenario Generation for an Investment Optimization Problem

HMM Based Scenario Generation for an Investment Optimization Problem

The Geometric Brownian motion (GBM) is a standard method for modelling financial time series. An important criticism of this method is that the parameters of the GBM are assumed to be constants; due to this fact, important features of the time series, like extreme behaviour or volatility clustering cannot be captured. We propose an approach by which the parameters of the GBM are able to switch between regimes, more precisely they are governed by a hidden Markov chain. Thus, we model the financial time series via a hidden Markov model (HMM) with a GBM in each state. Using this approach, we generate scenarios for a financial portfolio optimization problem in which the portfolio CVaR is minimized. Numerical results are presented.

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2020-04-06T11:07:01+00:00 7 December 2018|